Small-business owners bedeviled by expense calculations for their home office tax deductions can take advantage of an IRS rule that offers a potentially less time-consuming way to figure out some of those costs. But it saves money only in certain situations.
The rule lets you calculate expenses related to the business use of a home based on a simple multiplier: $5 per square foot. It applies only to home-ownership and maintenance costs, including deductible mortgage interest, real-estate taxes, homeowners insurance, repairs, and utilities. Other expenses related to your business, such as advertising, supplies, and wages, still need to be itemized to obtain the home office tax deduction.
Before this rule took effect for 2013 returns, to apportion some of the costs of maintaining your home to your business expenses for the home office tax deduction, you had to create a factor: the square footage of your home-office space divided by your home’s total square footage. Then you applied that factor to your total home-related expenses. Now all you need do is multiply the square footage of the office space by $5 and report that figure on line 30 of IRS Schedule C.
See our Income Tax Guide for more advice and tips on preparing, filing and saving on your income tax return.
New rule offers flexibility
You can apply the $5 multiplier to up to 300 square feet of your home office space, for a total of $1,500. A business that uses a room that’s 10x10 feet, for instance, could claim a business-use-of-home expense of $500, or $5 times 100 square feet, toward the home office tax deduction. But the new method doesn’t reduce your mortgage interest or property-tax deductions. You still report those on IRS Schedule A.
You can still use the old way to determine your expenses. In fact, in any year you can use whichever method saves you more. But you can’t amend a previous return to use the other method. And when you use the simplified method, you can’t carry over expenses from a prior tax year in which you used the regular method. (For more information, check out IRS Publication 587, “Business Use of Your Home.”
The simplified method is a no-brainer when your expenses are reliably less than $5 per square foot. That’s easy to determine if your expenses haven’t changed much from last year. Multiply your home-office square footage by $5 and compare the dollar result with the sum on line 30 of last year’s Schedule C. If the $5 method yields the higher figure, go with that. “Someone with low home-office expenses, no mortgage left to pay, and low property taxes is a perfect candidate,” says Lawrence Pon, a certified public accountant and certified financial planner from Redwood City, Calif.
If home-related expenses typically hover around $5 per square foot, however, you won’t save time. To compare the savings from each method, you’ll still have to itemize and add up all business expenses as you’ve always done.
One caveat: The simplified method doesn’t allow you to include depreciation of your home in business expenses, which is possible with the old method. In the short run, you’ll lose that potential savings. In the long run, though, the simplified method could prove to be a blessing, Pon says. With this method you won’t have to subtract—or “recapture”—the depreciation from your home’s basis when you sell it, as you must do under the old method. That lower basis could mean higher capital gains taxes on the profit. (Federal capital gains tax applies when the profit exceeds $500,000 per couple and $250,000 per single person, assuming they meet certain qualifications.)
Other IRS rules still apply
Regardless of your choice of expensing rule for home office tax deductions, you must still comply with IRS definitions of a home office: a room or delineated space furnished and equipped only for business use. Got a TV near your desk? Be prepared to defend why watching those reruns of “Law and Order” is strictly business.
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